Should I change tax exempt to total bond

[vchiu25]

Im retiring next year. Im wondering if I should switch my bond from tax exempt to taxable since I will be in lower tax bracket

but I’m not sure about how it will affect my qualified stock dividend tax rate.

I understand if I’m in 12% tax bracket my qualified dividend won’t be taxed. Is it correct tax exempt income is not part of bracket calculation?

My qualified stock dividend is in 12% bracket but if I add bond dividend it will put me a little bit over. Would I then have to pay 15% tax on all the qualified dividend?

Ps for 60/40 I don’t have enough room in tax advantage for my bond

[retiredjg]

Changing from tax-exempt bonds to taxable bonds would be a common thing to do when entering retirement if one's income goes down.

I think you are understanding it correctly. Taxable interest will increase your taxable income and that can change the tax rate on your qualified dividends.

But...In the long run, tax-exempt bonds should return less than taxable bonds. So in order to keep the 0% rate on your qualified dividends, you actually also have to make less money.

The best solution is to remove the bonds from your taxable account. Can you achieve the portfolio you want without bonds in taxable?

If not, it might be worth keeping the tax-exempt bonds because of the 27% marginal rate (sometimes called a shadow rate) that will occur on part of your income if you change to using taxable bonds instead of tax-exempt bonds.

[Hacksawdave]

OP, there was not much information here to help me give you an answer. I did find an old post from last year where you stated you are 40, meaning you are going to retire at 42. Since you are too young for tapping retirement funds or SS, what is your expected income and cash flow in early retirement, and at what rates based upon asset type?

Tax exempt interest does not count against QD/LTCG zero rate, ordinary income does. Non-qualified dividends count as ordinary income. I deployed this strategy in my own retirement started in 2020 at age 56.

[retiredjg]

My qualified stock dividend is in 12% bracket but if I add bond dividend it will put me a little bit over. Would I then have to pay 15% tax on all the qualified dividend?

No. But numbers are needed to know how much.

The marginal rate on some of those dollars would be 27%, not 15%. But any qualified dividends "below the line" are still taxed at 0%. With some numbers, this could be explained better.

Ps for 60/40 I don’t have enough room in tax advantage for my bond

Ok. If you switch to taxable bonds, some of that bond interest will be taxed at 27%. This makes the tax-exempt bond more attractive than one would think if you didn't know that.

[vchiu25]

Thanks for the feedback

To give more context. I’m 42, single no state tax. I have 3.5m portfolio that looks like this

1.2 million in bond (500k in 401k and 600k in taxable)
2.3 million in stock (70/30 US and intentional)

By my calculations my dividend will put me on the cusp between 12-22% tax bracket

I’m wondering if I should keep 500k in tax exempt or change to total bond when I retire next year

Are there any action I can take to make it more tax efficient when I have no salary?

[retiredjg]

Thanks for the feedback

To give more context. I’m 42, single no state tax. I have 3.5m portfolio that looks like this

1.2 million in bond (500k in 401k and 600k in taxable)
2.3 million in stock (70/30 US and intentional)

By my calculations my dividend will put me on the cusp between 12-22% tax bracket

I’m wondering if I should keep 500k in tax exempt or change to total bond when I retire next year

Are there any action I can take to make it more tax efficient when I have no salary?

With these numbers, it is hard to see how your total taxable income could be less than $44,625 (this year's number to stay under) even if all of the bonds in taxable are tax exempt. Is that what you are telling us?

[EnjoyIt]

OP,
I think you may be misunderstanding tax brackets. When you go from the 12% tax bracket into the 22%, not all of your income will be taxed at 22%. Only the amount you went over. Same goes for qualified dividends. Not all of your dividends will be taxed at 15%. Only the amount that is above that tax bracket will be taxed.

So if only a few thousand is hitting the next tax bracket, it really isn’t a big deal. Realistically, the best solution is to sell some bonds in taxable and by equities and then sell some equities in your 401k and buy bonds so that you keep your desired asset allocation.

[vchiu25]

At 60/40 my bond will definitely spill over into taxable.

I’m wondering how to adjust my portfolio in retirement. The two potential change I’m contemplating are

1) convert tax exempt to total bond in taxable
2) move more bond from taxable into Roth

Does either of these actions make sense?

[retired@50]

At 60/40 my bond will definitely spill over into taxable.

I’m wondering how to adjust my portfolio in retirement. The two potential change I’m contemplating are

1) convert tax exempt to total bond in taxable
2) move more bond from taxable into Roth

Does either of these actions make sense?

The bonds have to go someplace.

I recently read in one of Larry Swedroe's books that putting bonds in tax deferred and Roth is preferable to using a taxable account to hold taxable bonds. "Your Complete Guide to a Successful and Secure Retirement" by Larry Swedroe and Kevin Grogan - 2nd edition 2021.

Regards,

[retiredjg]

I don't think exchanging to taxable bonds makes sense because of the 27% marginal rate. Putting some bonds into Roth IRA might make sense but that is unthinkable by many members of this community (I don't happen to be one who thinks that).

But these things are hard to visualize with so little information. What are the relative sizes of each account....taxable/tax deferred/Roth?

Did you see my question about the taxable income from the portfolio? Is it really under $44,625 (plus deductions)? Even if it is, have you considered that doing Roth conversions now (and being in a higher bracket for a few years) might be better than letting your tax deferred account grow for decades and then being taxed at higher rates than we have for the next few years?

[Hacksawdave]

With the little information provided, I can only guess the tax-exempt fund is VTEAX, and had a balance beginning last year of 130,000? I ran two spreadsheets with VTEAX and VBTLX using distribution per share for 2022 based on the $130,000. I came up with compounded gross dividends of $3,215 for VTEAX and $3,088 for VBTLX. Taking a 27% federal tax out of VBTLX reduces the net dividend to $2,554. I know which one of the two I would choose for myself, but instead have VCLAX CA Tax-exempt Longs as I live in CA.